Using Modified Duration

Quantitative Finance Level 2

A fixed coupon that expires in 10 years with a face value of $1000 is currently priced at $1200. It has a modified duration of 2.5. What would be the bond price if yield increased by 1%?

Note: Ignore convexity considerations


The answer is 1170.

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Calvin Lin by Calvin Lin

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1 solution

Chew-Seong Cheong
Mar 16, 2015

Modified duration approximates the change in bond price due to yield change. The change in bond price due to an increase in yield is given by:

Δ P = D M o d Δ y = 2.5 × 0.01 = 0.025 \Delta P =D_{Mod} \Delta y = 2.5\times 0.01 =0.025

Therefore the new price 1200 × ( 1 − 0.025 ) = 1170 1200 \times (1-0.025) =\boxed {1170 }

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